<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended October 31, 1999
or
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from _____ to _____
Commission file number: 0-24346
VIDEO UPDATE, INC.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Delaware 41-1461110
- ------------------------------- ------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
3100 World Trade Center
30 East 7th Street
St. Paul, Minnesota 55101
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices)
(Zip Code)
(651) 312-2222
- --------------------------------------------------------------------------------
(Registrant's Telephone Number, Including Area Code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------- -------
The number of shares of Class A Common Stock, $.01 par value, outstanding
at December 13, 1999 is 29,278,457.
<PAGE>
VIDEO UPDATE, INC.
INDEX
PART I - FINANCIAL INFORMATION PAGE NO.
- ------------------------------ --------
Item 1. Financial Statements
Consolidated Balance Sheets - April 30, 1999 and
October 31, 1999 3
Consolidated Statements of Operations - Three Months
and Six Months ended October 31, 1998 and October 31, 1999 4
Consolidated Statements of Cash Flows - Six Months ended
October 31, 1998 and October 31, 1999 5
Notes to Consolidated Financial Statements - October
31, 1999 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings 17
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 18
- ----------
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PART I - FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
Video Update, Inc.
Consolidated Balance Sheets
(In thousands, except share and per share amounts)
Assets
<TABLE>
<CAPTION>
April 30, October 31,
1999 1999
-------------------------
(Unaudited)
<S> <C> <C>
Cash and cash equivalents $ 1,235 $ 1,113
Accounts receivable 3,826 3,739
Merchandise inventory 6,393 9,099
Video and game rental inventory - net 45,040 42,011
Property and equipment - net 59,395 54,622
Prepaid expenses 6,419 1,231
Goodwill - net 77,715 75,368
Other assets 7,185 7,449
--------- ---------
Total assets $ 207,208 $ 194,632
========= =========
Liabilities and Stockholders' Equity
Notes payable $ 116,014 $ 141,115
Accounts payable 56,055 25,193
Accrued expenses 23,054 25,275
Accrued rent 7,118 6,998
Accrued compensation 8,062 7,251
--------- ---------
Total liabilities 210,303 205,832
--------- ---------
Commitments and contingencies
Preferred Stock, par value $.01 per share:
Authorized shares -- 5,000,000
Issued shares - none -- --
Class A Common Stock, par value $.01 per share:
Authorized shares -- 60,000,000
Issued and outstanding shares -- 29,278,457
at April 30, 1999 and October 31, 1999 293 293
Additional paid-in capital 116,372 120,776
Retained deficit (118,045) (129,658)
Foreign currency translation (1,715) (2,611)
--------- ---------
Total stockholders' equity (3,095) (11,200)
--------- ---------
Total liabilities and stockholders' equity $ 207,208 $ 194,632
========= =========
</TABLE>
See accompanying notes.
Note: The balance sheet at April 30, 1999 has been derived from the audited
financial statements at that date but does not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
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Video Update, Inc.
Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
October 31, October 31,
---------------------- ----------------------
1998 1999 1998 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Rental revenue $ 53,359 $ 48,563 $ 108,655 $ 102,530
Product sales 8,540 5,587 14,681 11,487
Service fees 285 337 541 534
--------- --------- --------- ---------
62,184 54,487 123,877 114,551
Costs and expenses:
Store operating expenses 60,043 50,827 114,757 101,711
Selling, general and administrative 4,088 5,389 9,644 9,849
Cost of product sales 6,398 3,929 9,946 7,141
Store closing charge -- (1,662) -- (3,315)
Amortization of goodwill 1,169 1,089 2,120 2,164
--------- --------- --------- ---------
71,698 59,572 136,467 117,550
--------- --------- --------- ---------
Operating loss (9,514) (5,085) (12,590) (2,999)
Interest expense (3,300) (4,797) (6,773) (8,794)
Other income 185 133 256 180
--------- --------- --------- ---------
(3,115) (4,664) (6,517) (8,614)
--------- --------- --------- ---------
Loss before income taxes (12,629) (9,749) (19,107) (11,613)
Income tax expense -- -- -- --
--------- --------- --------- ---------
Net loss $ (12,629) $ (9,749) $ (19,107) $ (11,613)
========= ========= ========= =========
Net loss per share-basic and diluted $ (0.43) $ (0.33) $ (0.65) $ (0.40)
========= ========= ========= =========
</TABLE>
See accompanying notes.
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<PAGE>
Video Update, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
<TABLE>
<CAPTION>
Six Months Ended
October 31,
--------------------
1998 1999
-------- --------
<S> <C> <C>
Operating activities
Net loss $(19,107) $(11,613)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 43,429 32,623
Store closing reserve -- (3,315)
Accrual adjustment -- (3,446)
(Gain) loss on disposal of property and equipment 46 (34)
Changes in operating assets and liabilities, net
of acquisitions of businesses:
Accounts receivable 339 87
Merchandise inventory (3,500) (2,706)
Income taxes 2,079 --
Other assets (525) 4,010
Accounts payable 11,673 (6,918)
Accrued rent 1,314 (120)
Accrued liabilities (1,064) 4,901
-------- --------
Net cash provided by operating activities 34,684 13,469
Investing activities
Purchase of video and game rental inventory (35,753) (20,659)
Purchase of property and equipment (8,035) (847)
Disposal of property and equipment -- 250
Investment in businesses, net of cash acquired (169) --
-------- --------
Net cash used in investing activities (43,957) (21,256)
Financing activities
Proceeds from notes payable 23,040 29,550
Payments of notes payable (12,937) (20,989)
-------- --------
Net cash provided by financing activities 10,103 8,561
-------- --------
Effect of exchange rate changes on cash (1,433) (896)
Decrease in cash and cash equivalents (603) (122)
Cash and cash equivalents at beginning of the
period 1,433 1,235
-------- --------
Cash and cash equivalents at end of the period $ 830 $ 1,113
======== ========
</TABLE>
See accompanying notes.
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VIDEO UPDATE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
OCTOBER 31, 1999
(Unaudited)
1. General
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six months ended October 31, 1999 are
not necessarily indicative of the results that may be expected for the nine
months ending January 31, 2000 (in December 1998, the Company's Board of
Directors approved a resolution changing the Company's fiscal year-end from
April 30 to January 31, effective January 31, 2000). Certain prior year items
have been reclassified to conform with the fiscal 2000 presentation. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's annual report on Form 10-K for the year ended
April 30, 1999.
2. Earnings Per Share
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings per Share ("Statement 128").
Statement 128 replaced the previously reported primary and fully diluted
earnings per share with basic and diluted earnings per share. Unlike primary
earnings per share, basic earnings per share excluded any dilutive effect of
options, warrants and convertible securities. Diluted earnings per share is very
similar to the previously reported fully diluted earnings per share. All
earnings per share amounts for all periods have been presented, and when
necessary, restated to conform to the Statement 128 requirements.
The following table is a reconciliation of the basic and diluted earnings
per share computation:
<TABLE>
<CAPTION>
Three Months Six Months
Ended October 31, Ended October 31,
--------------------- -----------------------
1998 1999 1998 1999
--------- --------- ---------- --------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Numerator:
- ----------
Numerator for basic and diluted earnings per share--net loss $ (12,629) $ (9,749) $ (19,107) $ (11,613)
========= ========= ========= ==========
Denominator:
- ------------
Denominator for basic earnings per share--weighted-average
shares
Class A common shares 29,278 29,278 29,278 29,278
Class B common shares -- -- -- --
--------- --------- --------- ----------
Denominator for basis earnings per share 29,278 29,278 29,278 29,278
Effect of dilutive securities:
Contingent stock acquisition -- -- -- --
--------- --------- --------- ----------
Dilutive potential common shares -- -- -- --
--------- --------- --------- ----------
Denominator for diluted earnings per share--
adjusted weighted-average shares and assumed conversions 29,278 29,278 29,278 29,278
========= ========= ========= ==========
Basic net loss per share $ (0.43) $ (0.33) $ (0.65) $ (0.40)
========= ========= ========= ==========
Diluted net loss per share $ (0.43) $ (0.33) $ (0.65) $ (0.40)
========= ========= ========= ==========
</TABLE>
3. Comprehensive Loss
As of May 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, Reporting Comprehensive Income ("Statement 130"). Statement
130 establishes new rules for the reporting and display of comprehensive income
and its components; however, the adoption of Statement 130 had no impact on the
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Company's net income (loss) or stockholders' equity. Statement 130 requires
unrealized gains or losses on the Company's foreign currency translation
adjustments, which prior to adoption were reported separately in stockholders'
equity to be included in other comprehensive income. Prior years' financial
statements have been reclassified to conform to the requirements of Statement
130. During the three months ended October 31, 1998 and 1999, total
comprehensive loss amounted to $13,080,000 and $10,583,000, respectively; and
during the six months ended October 31, 1998 and 1999, total comprehensive loss
amounted to $20,540,000 and $12,509,000, respectively.
4. Income Tax Expense
At the end of the October 31, 1999 quarter, the Company estimated that its
effective tax rate for the year ended January 31, 2000 would be 0%. The Company
has therefore used this rate in providing for income taxes in the current
quarter. The Company evaluates and estimates its effective tax rate at the end
of each interim period during fiscal 2000.
5. Provision for Store Closing and Other Charges
During the three months ended and six months ended October 31, 1999,
$553,000 and $629,000, respectively, was expended for lease terminations and
miscellaneous closing costs related to the Company's 1998 business restructuring
plan. Successful negotiations of lease terminations resulted in an excess
reserve of approximately $0 and $250,000 respectively that was recorded as an
increase to net income.
During the three months ended and six months ended October 31, 1999,
$859,000 and $1,289,000, respectively, was expended for lease terminations and
miscellaneous closing costs related to the Company's 1999 business restructuring
plan. Successful negotiations of lease terminations resulted in an excess
reserve of approximately $1,662,000 and $3,315,000, respectively that was
recorded as an increase to net income.
6. Legal Proceedings
In connection with the acquisition of the assets of Videoland, Inc.
("Videoland") in November 1995, the Company issued 239,163 shares of its Class A
Common Stock (the "Videoland Shares") to the sellers of the assets of Videoland
(the "Videoland Sellers"). With respect to the Videoland Shares, the Company
agreed to make a deficiency payment in October 1996 to the Videoland Sellers if
the gross proceeds received by such sellers from the sale of the Videoland
Shares during the six months from March 1996 through September 1996 is not equal
to the number of shares of Videoland Shares sold multiplied by $12.00. The
Videoland Sellers were subject to certain "lockup" or sale restrictions as a
condition to any deficiency payment. The Company initiated an action in federal
district court in Minnesota for a declaratory judgment that the Videoland
Sellers are not entitled to any deficiency payment in light of the failure by
such sellers to comply with the lockup or sale restrictions. In January 1998,
the court entered a judgment, payable in the Company's stock or cash, against
the Company in the amount of $1,220,403 plus interest from October 1996, and
attorney's fees. The Company appealed the judgment to the Eighth Circuit. The
appeal was denied. The Company is exploring further avenues of relief, including
but not limited to the satisfaction of a portion of the judgment by a transfer
of the Company's stock, of which no assurances can be given. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action.
In May 1998, Rousnam Video, Inc., a Michigan corporation and Hani (Al)
Monsour (collectively "Monsour") filed a lawsuit in state court (Macomb County,
Michigan) claiming amounts due pursuant to post-closing adjustments contemplated
in connection with an Asset Purchase Agreement among Monsour and Moovies, Inc.
dated as of March 14, 1997, and the alleged default on a Promissory Note among
Monsour and Moovies, Inc. in the amount of $2,000,000 which is currently
reflected in notes payable. The trial court has ruled in favor of the plaintiffs
on a motion for summary judgment, and a judgment for $2,370,195 has been entered
against the Company. The Company believes it has meritorious grounds for its
appeal which is currently pending, although assurances cannot be given as to the
outcome of such action. The foregoing description is qualified in its entirety
by reference to the full text of the complaint and papers on file in the action.
In May 1998, four stockholders filed suit in the US District Court for the
Central District of California. The plaintiff stockholders allege that Mr.
Potter and the Company made false and misleading statements or omitted material
information about the Company and the video industry during the period April
1995 to September 1996, the
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date of its subsequent public offering. Plaintiffs are seeking "at least the sum
of $967,967," plus interest, additional damages and attorneys' fees. The Company
and Mr. Potter believe that the claims are unsubstantiated, without merit and
they intend to defend the matter vigorously. A motion to dismiss the First
Amended Complaint was granted, but the court allowed Plaintiffs to re-file. At
present, the Second Amended Complaint has been filed. The Company is in the
process of discovery, which is not scheduled to close until December 1999. In
addition, the Company and Mr. Potter have reached a tentative settlement with
the plaintiffs. Although no assurances can be given, the Company expects that
the settlement will become final in late December 1999 or early January 2000.
The foregoing description is qualified in its entirety by reference to the full
text of the complaint and papers on file in the action.
In August 1998, the Company filed suit in federal court in Oregon against
Rentrak Corporation, an Oregon Corporation. The Company alleges that Rentrak has
violated the federal antitrust law, given Rentrak's position in the market and
its exercise of monopoly power. Rentrak has counter-claimed for amounts it
alleges were owed by Moovies, Inc. prior to the acquisition of Moovies, Inc. by
the Company; the Company has denied that any sums are due. Discovery in the
matter is now scheduled to be completed in June 2000. The Company intends to
pursue its claims aggressively, although assurances cannot be given as to the
outcome of this matter. The foregoing description is qualified in its entirety
by reference to the full text of the complaint and papers on file in the action.
On June 20, 1999, Allen Industries, Inc., a North Carolina corporation,
filed a lawsuit against the Company claiming approximately $3 million in unpaid
invoices arising out of the conversion of various Moovies stores. The Company
has asserted that Allen Industries breached its contract and performed defective
work. The Company believes that the claims of Allen Industries are
unsubstantiated and without merit. The Company intends to defend the matter
vigorously. The foregoing description is qualified in its entirety by reference
to the full text of the complaint and papers on file in the action.
In addition to the above, the Company is involved in various legal
proceedings arising during the normal course of conducting business. Management
believes that the resolution of these proceedings will not have any material
adverse impact on the Company's financial statements.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion of the financial condition and results of
operations should be read in conjunction with the Company's unaudited
consolidated financial statements and notes thereto appearing elsewhere herein.
Overview
The Company franchised its first store in January 1983 and opened its first
Company-owned store in September 1989. By July 1994, when the Company completed
its initial public offering, the Company had grown to 15 Company-owned stores
and 30 franchised stores. Subsequently, the Company substantially accelerated
its growth and as of October 31, 1999 operated 590 Company-owned stores in 31
states and five provinces in Canada, and has 53 franchised stores predominantly
in the United States. The majority of the Company's stores located in the United
States are superstores. Superstores are video specialty stores that carry more
than 7,500 rental units.
The Company generates revenues primarily from the rental of videocassettes
and video games, from service fees from its franchisees and from the sale of
products. As reflected in the chart below, rental revenues at Video Update
stores have accounted for the substantial majority of the Company's revenues.
The Company expects that this trend will continue.
Three Months Six Months
Ended October 31, Ended October 31,
------------------- -------------------
1998 1999 1998 1999
-------- -------- -------- --------
(In thousands) (In thousands)
Rental revenue $ 53,359 $ 48,563 $108,655 $102,530
Product sales 8,540 5,587 14,681 11,487
Service fees 285 337 541 534
-------- -------- -------- --------
Total revenues $ 62,184 $ 54,487 $123,877 $114,551
======== ======== ======== ========
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Operating Results
The table below sets forth the percentage of revenues represented by
certain items included in the Company's statements of operations for the periods
indicated.
Three Months Six Months
Ended October 31, Ended October 31,
------------------- -------------------
1998 1999 1998 1999
----- ----- ----- -----
Revenues:
Rental revenue 85.8 % 89.1 % 87.7 % 89.5 %
Product sales 13.7 10.3 11.9 10.0
Service fees 0.5 0.6 0.4 0.5
----- ----- ----- -----
Total revenues 100.0 100.0 100.0 100.0
Costs and expenses:
Store operating expenses 96.5 93.3 92.6 88.8
Selling, general and
administrative 6.6 9.9 7.8 8.6
Cost of product sales 10.3 7.2 8.0 6.2
Store closing charge -- (3.1) -- (2.9)
Amortization of goodwill 1.9 2.0 1.7 1.9
----- ----- ----- -----
Total cost and expenses 115.3 109.3 110.1 102.6
----- ----- ----- -----
Operating (loss) (15.3) (9.3) (10.1) (2.6)
Other income (expense):
Interest expense (5.3) (8.8) (5.5) (7.7)
Other income 0.3 0.2 0.2 0.2
----- ----- ----- -----
Total other income (expense) (5.0) (8.6) (5.3) (7.5)
----- ----- ----- -----
Loss before income taxes (20.3) (17.9) (15.4) (10.1)
Income tax expense -- -- -- --
----- ----- ----- -----
Net loss (20.3)% (17.9)% (15.4)% (10.1)%
===== ===== ===== =====
Three and Six Months Ended October 31, 1998 Compared to Three and Six Months
Ended October 31, 1999
Rental revenue
- --------------
Rental revenue was approximately $53,359,000 and $48,563,000, or 85.8% and
89.1% of total revenues for the three months ended October 1998 and 1999,
respectively. The decrease in rental revenue of $4,796,000 was primarily
attributed to the closing of under-performing stores. Same store sales decreased
6% for the quarter.
Rental revenue was approximately $108,655,000 and $102,530,000, or 87.7%
and 89.5% of total revenues for the six months ended October 31, 1998 and 1999,
respectively. The decrease in rental revenue of $6,125,000 was primarily
attributed to the closing of under-performing stores pursuant to the Company's
business restructuring plans of fiscal 1998 and 1999 and to increased
competition in several key markets. Of the 78 stores closed since October 31,
1998, 56 relate to the Company's fiscal 1999 business restructuring plan. Same
store sales decreased 3% for the six months ended October 31, 1999.
Product sales
- -------------
Product sales were approximately $8,540,000 and $5,587,000, or 13.7% and
10.3% of total revenues for the three months ended October 31, 1998 and 1999,
respectively. The decrease in product sales of $2,953,000 was attributed to the
closing of under-performing stores and the high volume of Titanic video sales
that occurred in the second quarter of fiscal 1999.
Product sales were approximately $14,681,000 and $11,487,000, or 11.9% and
10.0% of total revenues for the six months ended October 31, 1998 and 1999,
respectively. The decrease in product sales of $3,194,000 was
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attributed to the closing of under-performing stores and the high volume of
Titanic video sales that occurred in the second quarter of fiscal 1999.
Service fees
- ------------
Service fees were approximately $285,000 and $337,000, or 0.5% and 0.6% of
total revenues for the three months ended October 31, 1998 and 1999,
respectively. Continuing service fees and royalties from franchisees accounted
for about 89% of total service fees.
Service fees were approximately $541,000 and $534,000, or 0.4% and 0.5% of
total revenues for the six months ended October 31, 1998 and 1999, respectively.
Continuing service fees and royalties from franchisees accounted for about 87%
of total service fees.
Store operating expenses
- ------------------------
Store operating expenses were approximately $60,043,000 and $50,827,000, or
96.5% and 93.3% of total revenues for the three months ended October 31, 1998
and 1999, respectively. The decrease in store operating expenses of $9,216,000
and decrease in store operating expenses as a percentage of total revenues was
primarily due to the closing of under-performing stores.
Store operating expenses consist primarily of compensation and related
expenses including regional management expenses, occupancy expenses, and the
cost of rental tapes and video games. Operating expenses were approximately
$114,757,000 and $101,711,000, or 92.6% and 88.8% of total revenues for the six
months ended October 31, 1998 and 1999, respectively. The decrease in store
operating expenses of $13,046,000 and the decrease in store operating expenses
as a percentage of total revenues was primarily due to the closing of 78
under-performing stores since October 31, 1998 and other cost cutting measures
such as reduction of management overhead, positive resolution of disputed
accounts payable balances, and selected downsizing of stores. The Company is
also reviewing operating statistics such as store hour coverage and supervisory
ratios to determine the most cost effective way to provide exceptional customer
service.
<TABLE>
<CAPTION>
Three Months
Ended October 31, Percent of Revenue
----------------- ------------------
1998 1999 1998 1999
------- ------- ---- ----
<S> <C> <C> <C> <C>
Cost of rental revenue $19,578 $14,373 31.5% 26.4%
Occupancy expenses 17,979 16,315 28.9 29.9
Compensation and related expenses 15,943 14,047 25.6 25.8
Furniture, fixtures, and equipment expenses 3,677 3,718 5.9 6.8
Other store operating (income) expenses 2,866 2,374 4.6 4.4
------- ------- ---- ----
Total store operating expenses $60,043 $50,827 96.5% 93.3%
======= ======= ==== ====
Six Months
Ended October 31, Percent of Revenue
----------------- ------------------
1998 1999 1998 1999
------- ------- ---- ----
Cost of rental revenue $ 36,061 $ 29,836 29.1% 26.1%
Occupancy expenses 36,218 33,829 29.2 29.5
Compensation and related expenses 30,716 28,980 24.8 25.3
Furniture, fixtures, and equipment expenses 6,788 7,345 5.5 6.4
Other store operating (income) expenses 4,974 1,721 4.0 1.5
-------- -------- ---- ----
Total store operating expenses $114,757 $101,711 92.6% 88.8%
======== ======== ==== ====
</TABLE>
Cost of rental revenue was approximately was approximately $19,578,000 and
$14,373,000, or 31.5% and 26.4% of total revenues for the three months ended
October 31, 1998 and 1999, respectively. The decrease of $5,205,000 was
primarily attributed to the closing of 78 under-performing stores since October
31, 1998. The decrease in the cost of rental revenue as a percentage of revenues
was primarily the result of a change in the method of amortization of rental
tapes partially offset by an increase in revenue sharing expenses. Effective
February 1, 1999, the Company changed the amortization policy for videos to more
appropriately reflect the economics of revenue sharing agreements with studios
that result in satisfying consumer demand over a shorter period of time. The
adoption of the new method of amortization was accounted for as a change in
accounting estimate effected by a change in accounting principle in the fourth
quarter of fiscal year 1999. The Company recorded a pre-tax charge of
approximately $50,629,000 in the fourth quarter of fiscal year 1999 which had
the effect of decreasing amortizable inventory in fiscal year 2000 versus fiscal
year 1999.
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Cost of rental revenue was approximately $36,061,000 and $29,836,000, or
29.1% and 26.1% of total revenues for the six months ended October 31, 1998 and
1999, respectively. Cost of rental revenue reflects the amortization of
videocassettes and video games, revenue sharing expenses, and fees paid to
videocassette and video game suppliers. The decrease of $6,225,000 was primarily
attributable to the closing of 78 under-performing stores since October 31,
1998. The decrease in cost of rental revenue as a percentage of revenues was
primarily the result of a change in the amortization policy discussed above.
Occupancy expenses were approximately $17,979,000 and $16,315,000, or 28.9%
and 29.9% of total revenues for the three months ended October 31, 1998 and
1999, respectively. The decrease of approximately $1,664,000 was primarily due
to the closing of under-performing stores. The expense as a percentage of
revenue increased as a result of soft sales in the current fiscal year.
Occupancy expenses were approximately $36,218,000 and $33,829,000, or 29.2%
and 29.5% of total revenues for the six months ended October 31, 1998 and 1999,
respectively. The decrease of approximately $2,389,000 was primarily due to the
closing of 78 under-performing stores since October 31, 1998. The expense as a
percentage of revenue increased as a result of soft sales in the current fiscal
year.
Compensation and related expenses were approximately $15,943,000 and
$14,047,000, or 25.6% and 25.8% of total revenues for the three months ended
October 31, 1998 and 1999, respectively. The decrease of approximately
$1,896,000 was primarily due to the closing of under-performing stores. The
expense as a percentage of revenue increased as a result of soft sales in the
current fiscal year.
Compensation and related expenses were approximately $30,716,000 and
$28,980,000, or 24.8% and 25.3% of total revenues for the six months ended
October 31, 1998 and 1999, respectively. The decrease of approximately
$1,736,000 was primarily due to the closing of 78 under-performing stores since
October 31, 1998. The expense as a percentage of revenue increased as a result
of soft sales in the current fiscal year.
Selling, general and administrative
- -----------------------------------
Selling, general and administrative expenses were approximately $4,088,000
and $5,389,000, or 6.6% and 9.9% of total revenues for the three months ended
October 31, 1998 and 1999, respectively. The increase of approximately
$1,301,000 was due to legal fees incurred to amend the senior credit facility
and higher occupancy costs.
Selling, general and administrative expenses were approximately $9,644,000
and $9,849,000, or 7.8% and 8.6% of total revenues for the six months ended
October 31, 1998 and 1999, respectively. The increase of approximately $205,000
was due to legal fees incurred to amend the senior credit facility and higher
occupancy costs partially offset by positive resolution of disputed accounts
payable balances. The expense as a percentage of revenue increased as a result
of soft sales in the current fiscal year.
Cost of product sales
- ---------------------
Cost of product sales was approximately $6,398,000 and $3,929,000, or 10.3%
and 7.2% of total revenues for the three months ended October 31, 1998 and 1999,
respectively. The cost of product sales as a percentage of total product sales
was approximately 74.9% and 70.3% for fiscal 1998 and 1999, respectively. The
decrease in the cost of product sales as a percentage of total product sales was
due to a change in product mix and the high volume of Titanic video sales that
occurred in the second quarter of fiscal 1999.
Cost of product sales was approximately $9,946,000 and $7,141,000, or 8.0%
and 6.2% of total revenues for the six months ended October 31, 1998 and 1999,
respectively. The cost of product sales as a percentage of total product sales
revenue was approximately 67.7% and 62.2% for fiscal 1998 and 1999,
respectively. The decrease in the cost of product sales as a percentage of total
product sales was due to a change in product mix and the high volume of Titanic
video sales that occurred in the second quarter of fiscal 1999. The Company
anticipates that the
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<PAGE>
cost of product sales as a percentage of product sales will remain consistent
with historical results, but will fluctuate quarterly based upon customer
demands.
Store closing charge
- --------------------
During the fourth quarter of fiscal 1999, the Company adopted a business
restructuring plan to close approximately 70 under-performing stores. This
resulted in the Company recording a pre-tax charge of approximately $16,135,000
to cover lease termination charges, closing costs and asset write-downs for
these stores. During the three months and six months ended October 31, 1999, 56
stores were closed at a significantly lower cost to the Company than originally
planned which resulted in a gain of approximately $1,662,000 and $3,315,000,
respectively.
Amortization of goodwill
- ------------------------
Amortization of goodwill was approximately $1,169,000 and $1,089,000, or
1.9% and 2.0% of total revenues for the three months ended October 31, 1998 and
1999, respectively. The increase as a percentage of total sales was primarily
attributed to soft sales in the current fiscal year.
Amortization of goodwill was approximately $2,120,000 and $2,164,000, or
1.7% and 1.9% of total revenues for the six months ended October 31, 1998 and
1999, respectively. The increase as a percentage of total sales was primarily
attributable to soft sales in the current fiscal year.
Interest expense
- ----------------
Interest expense was approximately $3,300,000 and $4,797,000, or 5.3% and
8.8% of total revenues for the three months ended October 31, 1998 and 1999,
respectively. The increase of approximately $1,497,000 was primarily attributed
to interest on increased borrowings, a 0.75% increase of the overall interest
rate, and the issuance of warrants related to the additional term debt resulting
in an increase in interest expense.
Interest expense was approximately $6,773,000 and $8,794,000, or 5.5% and
7.7% of total revenues for the six months ended October 31, 1998 and 1999,
respectively. The increase of approximately $2,021,000 was primarily
attributable to interest on increased borrowings, a 0.75% increase of the
overall interest rate, and the issuance of warrants related to the additional
term debt resulting in an increase in interest expense.
Other income
- ------------
Other income was approximately $185,000 and $133,000, or 0.3% and 0.2% of
total revenues for the three months ended October 31, 1998 and 1999,
respectively.
Other income was approximately $256,000 and $180,000, or 0.2% and 0.2% of
total revenues for the six months ended October 31, 1998 and 1999, respectively.
Income taxes
- ------------
At the end of the October 31, 1999 quarter, the Company estimated that its
effective tax rate for the year ended January 31, 2000 would be 0%. The Company
has therefore used this rate in providing for income taxes in the current
quarter. The Company will evaluate and estimate its effective tax rate at the
end of each interim period during fiscal 2000.
Liquidity and Capital Resources
The Company has funded its operations through cash from operations, the
proceeds of prior equity and debt offerings, borrowings under bank facilities,
trade credit and equipment leases. The Company's principal capital requirements
are for the purchase of rental inventory, payments related to store closings,
payments related to aged accounts payable, payments of interest and principal
related to the Company's indebtedness.
At October 31, 1999, the Company had cash and cash equivalents of
approximately $1,113,000. The Company uses an unclassified balance sheet in its
financial statements, and as a result, does not classify its assets or
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<PAGE>
liabilities as current or non-current. If the Company were to use a classified
balance sheet, a portion of videocassette rental inventories would be classified
as non-current because they are not assets that are reasonably expected to be
completely realized in cash or sold in one year. The acquisition cost of these
inventories, however, would be reflected in current liabilities. The Company
believes that classification of videocassette rental inventories as non-current
assets would be misleading because it would not indicate the level of assets
expected to be converted into cash in the next year as a result of rentals or
sales of these videocassettes.
For the six months ended October 31, 1999, net cash provided by operating
activities was approximately $13,469,000. Net cash used in investing activities
was approximately $21,256,000, consisting primarily of approximately $847,000
for the purchase of property and equipment, and approximately $20,659,000 for
the purchase of video and game rental inventory. Net cash generated from
financing activities was approximately $8,561,000.
In March 1998 the Company completed the acquisition of Moovies, Inc.
("Moovies"). The Company issued approximately 9.3 million shares of Class A
Common Stock in exchange for Moovies common stock. The transaction was treated
as a tax-free exchange for federal income tax purposes and recorded under the
purchase method of accounting.
Simultaneous with the closing of the Moovies transaction, the Company
announced that a syndicate led by Banque Paribas had extended it a $120 million
senior credit facility (the "Senior Facility"). This Senior Facility replaced
the Company's previous line of credit. The Senior Facility consisted of the
following: (i) two term loans totaling $95 million; (ii) a $15 million capital
expenditure line; and, (iii) a $10 million revolving line. The Company borrowed
the $95 million of the two term loans in conjunction with the closing of the
merger and the proceeds were used to: (i) refinance approximately $35,000,000 of
outstanding indebtedness including accrued interest under the Company's previous
line of credit; (ii) refinance approximately $50,000,000 of indebtedness of
Moovies under Moovies' previous credit agreement; and (iii) pay transaction fees
and expenses relating to the Merger of approximately $10,000,000, (including
legal fees, accounting fees, and registration fees). The capital expenditure
line was primarily available to fund the conversion of the acquired Moovies
stores and integration costs, the opening of new stores and selected
acquisitions.
During the second quarter of fiscal 1999, the Company and the bank
syndicate amended the terms of the Senior Facility to, among other things: (i)
reduce the Senior Facility from $120 million to $115 million; (ii) revise
certain financial covenants; (iii) modify the terms of the capital expenditure
line to allow usage for working capital needs; (iv) increase the overall
interest rate by 0.5%; (v) add consent fees of $600,000 payable August 12, 1998
and $575,000 payable on August 12, 1999; and (vi) reprice warrants held by the
bank syndicate to a more current market price. During the third quarter of
fiscal 1999, the Company and the bank syndicate amended the terms of the Senior
Facility to, among other things; (i) permit a sale-leaseback transaction; (ii)
defer the January 31, 1999 principal payments to March 12, 1999; and (iii)
increase the overall interest rate by 0.25%. During the fourth quarter of fiscal
1999, the Company and the bank syndicate amended the terms of the Senior
Facility to, among other things; (i) defer the March 12, 1999 principal payments
to May 31, 1999; (ii) revise certain financial covenants; and (iii) add a
consent fee of $57,500 due on April 30, 1999 and May 15, 1999. As of October 31,
1999, the Company had $15 million outstanding under the capital expenditure line
and $5 million outstanding under the revolving line both of which are available
to fund working capital needs. As of October 31, 1999 the Company had no further
borrowing capacity available under its Senior Facility.
Effective May 28, 1999, the Company and the bank syndicate amended the
terms of the Senior Facility to, among other things; (i) increase the overall
Senior Facility with a new tranche of C Term loans in the aggregate amount of
$10.5 million maturing June 2006, and bearing 12% interest; (ii) revise certain
financial covenants; (iii) revise and defer certain principal payments; (iv)
increase the overall interest rate by 0.75%; and (v) reflect the issuance of
7,481,250 warrants at $0.8719 per share expiring June 2006. The Company is using
proceeds of the new C Term loans for, among other things, the purchase of rental
inventory, payments related to expected store closings, trade payables, and debt
service. The Company believes that its relationship with the Senior Facility
lenders is satisfactory and that it would be able to obtain any necessary
waivers, amendments or modifications to the Senior Facility if the Company's
operating performance causes it to fall short of certain financial covenants in
the Senior Facility, although no assurances can be given. If the Company is
unable to maintain such a level of operations, it will be required to reduce its
overall expenditures and expansion plans to comply with the covenants and
requirements of the Senior Facility. Additionally, any failure by the Company to
maintain its level of operations within the covenants and requirements of the
Senior Facility could cause the Company to be in default thereunder,
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<PAGE>
allowing the lenders to take legal action against the Company, including but not
limited to, the immediate acceleration of payment of borrowed funds, which could
materially and adversely affect the Company's operations. The immediate
acceleration of debt thereunder or the lack of further borrowing capacity, in
whole or in part, would have a material adverse effect on the Company's
operations and financial condition.
Amounts borrowed under the Senior Facility bear interest at variable rates
based on the "base rate" (i.e., the higher of the federal funds rate, plus 1/2
of 1% or the prime commercial lending rate) or the inter-bank Eurodollar rate
(approximately 8.25% and 5.37% per annum, respectively as of October 31, 1999)
plus an applicable margin rate that could range from 0.50% to 5.00%. Amounts
currently outstanding at October 31, 1999 had a weighted average rate of 9.72%.
The Senior Facility includes negative, affirmative and financial covenants
including, but not limited to, minimum free cash flow, consolidated indebtedness
to consolidated free cash flow, maximum leverage, minimum fixed charge coverage,
a prohibition or restriction on capital expenditures, debt and guarantees, liens
and encumbrances on any property, mergers, consolidations, investments,
advances, divestitures, change of business or conduct of business, joint
ventures, partnerships, the creation of new subsidiaries, dividends,
distributions, repurchases or redemptions of outstanding stock (including
options or warrants), the voluntary prepayment, repurchase redemption or
defeasance of debt, and the acquisition, sale or transfer, lease or
sale-leaseback of assets. The Senior Facility is secured by substantially all of
the Company's assets as well as by pledges of its stock in its subsidiaries,
which subsidiaries also have provided guarantees of the Company's obligations.
In May 1999, the Company issued Ingram Entertainment Inc., a supplier of
rental inventory ("Ingram"), a $14,000,000 subordinated promissory note in
respect to outstanding trade payable amounts from the Company. The note (the
"Ingram Note") bears interest at a rate of 12% per annum with principal and
interest payable monthly over three years. Simultaneous with the issuance of the
Ingram Note, the Company issued Ingram warrants to purchase 1,000,000 shares of
Class A Common Stock, at the then market price of $0.81 per share, which
warrants expire May 2004.
In September 1999, the Company settled its litigation with Sight & Sound
Distributors, Inc. ("Sight & Sound"). In connection with the settlement, the
Company has agreed to pay Sight & Sound an aggregate principal amount of
$6,500,000, with payments aggregating approximately $160,000 monthly over a
period of approximately three years. Interest on the unpaid balance will accrue
at a per annum rate of 8%.
During fiscal year 2000, the Company is proceeding with actions intended to
enhance prospects for revenue growth and profitability including the closing of
approximately 70 identified under-performing locations. The Company continues to
evaluate opportunities to reduce costs and improve revenues. The Company has
maintained a longstanding and satisfactory relationship with its primary product
vendors and has negotiated extended payment terms with several of these vendors.
The loss of its primary product vendors could have a material adverse effect on
the Company. The Company will continue to focus on reducing the aged accounts
payable with payments, the extension of terms, and negotiated settlements. If
the Company is unable to reduce the aged accounts payable to the satisfaction of
the trade creditors, it could have a material adverse effect on the Company.
Assuming the Company is able to maintain a satisfactory relationship with its
selected vendors, its bank lenders, and its trade creditors, the Company expects
that cash from operations, trade credits, equipment leases, available revenue
sharing arrangements, and available borrowings under the Senior Facility will be
sufficient to fund future inventory purchases and other working capital needs
for the next twelve months, although no assurances can be given that the Company
will not require additional sources of financing as a result of disappointing
operating results, or unanticipated cash needs or opportunities. Moreover, no
assurances can be given that such additional funds will be available on
satisfactory terms, if at all. If the Company is unable to obtain such
additional financing, the Company may be required to reduce its overall
expenditures and the Company's ability to maintain or expand its current level
of operations could be materially and adversely affected.
Each of Messrs. Potter and Bedard had issued notes to the Company (the
"Recourse Notes") in connection with previous stock option exercises, for
approximately $2,080,147 and $1,155,637, respectively, including accrued
interest through April 30, 1998. In fiscal 1999, the Recourse Notes accrued
additional interest of $147,097 and $81,721 for a total Recourse Note balance of
$2,227,244 and $1,237,358 for Messrs. Potter and Bedard, respectively.
Previously, the Company's Board had approved the accrual of bonuses to satisfy
the Recourse Notes, as well as the anticipated payroll tax liabilities to the
executives. The Company has satisfied all of its obligations to
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<PAGE>
Mr. Potter with respect to his Recourse Note and payroll tax and expects to
complete its obligations with respect to Mr. Bedard's Recourse Note over the
next twelve months.
The Company generally does not offer lines of credit or guarantees for the
obligations of its franchisees, although on occasion, the Company has made
short-term loans to current franchisees. The Company intends to evaluate the
possibility of providing loans or limited guarantees for certain franchisee
obligations, which in the aggregate are not expected to be material to the
Company's financial condition.
Substantially all Company-owned stores are in leased premises, except for
three stores that are located on premises owned by the Company. The Company
expects that most future stores will occupy leased premises.
In November 1998, the Company entered into a sale-leaseback arrangement
with respect to certain of its furniture, fixtures, equipment and signage used
in selected retail locations. Under the arrangement the Company obtained
approximately $5 million.
This Quarterly Report on Form 10-Q contains a number of forward looking
statements that involve risks and uncertainties. Any statements contained herein
(including without limitation statements to the effect that the Company or its
management "believes," "expects," "anticipates," "plans" and similar
expressions) that are not statements of historical fact should be considered
forward looking statements. Such statements are subject to the safe harbor
created by the Private Securities Litigation Reform Act of 1995. There are a
number of important factors that could cause the Company's results to differ
materially from those indicated by such forward looking statements including,
but not limited to, changes in business strategy or development plans, store
openings and closings, availability of products, availability of financing,
competition, management, ability to manage growth, loss of customers, weather
(particularly on weekends and holidays), consumer acceptance of new release
videocassette titles, and a variety of other factors, including risks and
uncertainties included in the Company's Annual Report on Form 10-K for the year
ended April 30, 1999. These factors include, without limitation, the following:
Inflation
To date, inflation has not had a material effect on the Company's business.
The Company anticipates that its business will be affected by general economic
trends. Although the Company has not operated during a period of high inflation,
it believes that it would generally be able to pass increased costs resulting
from inflation on to customers.
Seasonality and Quarterly Fluctuations
The video rental industry generally experiences revenue declines in April
and May, due in part to the change to Daylight Savings Time and to improved
weather, and in September and October, due in part to school openings and the
introduction of new network and cable television programs.
The Company's video rental business may be affected by other factors,
including acquisitions by the Company of existing video stores, additional and
existing competition, marketing programs, weather, special or unusual events,
variations in the number of superstore openings, and other factors that may
affect retailers in general.
The Company depends significantly on availability and consumer acceptance
of new release videocassette titles available for rental. To the extent that
available new release titles fail to stimulate consumer interest and retail
traffic, operating results could be materially adversely affected.
Year 2000 Compliance
The year 2000 ("Y2K") issue is the result of computer programs that were
written using two digits rather than four to define the applicable year. For
example, computer programs that have time-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. To the extent that
the Company's (and our vendors' and suppliers') software applications contain
source code that is unable to interpret appropriately the upcoming calendar year
2000 and beyond, some level of modification or replacement of such applications
have been necessary to avoid system failures and the temporary inability to
process transactions or engage in other normal business activities.
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<PAGE>
The Company's information services group has coordinated the Company's
internal Y2K compliance efforts and believes it has identified all
computer-based systems and applications (including embedded systems) the Company
uses in its operations that were not Y2K compliant. The Company also believes
that it has determined which modifications or replacements were necessary to
achieve such compliance. All replacement systems were developed and tested for
compliance before implementation into the Company's regular operations. All
existing internally developed systems requiring modifications were tested and
modified to achieve Y2K compliance. As a result of such system testing,
replacement, and modification, the Company believes that all of its business
critical systems have been remediated and tested for year 2000 dates and that
the Y2K issue will not have any material effect on the Company's business.
The Company has also examined its relationship with key outside vendors,
suppliers, and business partners with whom the Company has significant business
relationships to determine the degree of such outside parties' Y2K compliance.
The Company has been contacting such outside parties and attempting to seek
assurances that such parties will be Y2K compliant. The Company does not believe
that its relationship with any single third party is material to the Company's
operations and, therefore, the Company does not believe that the failure of any
single third party to be Y2K compliant would have a material adverse effect on
the Company. The Company believes that if it, or any third party with whom the
Company has a significant business relationship, has a Y2K related systems
failure, the most significant impact would likely be the inability, with respect
to a store or group of stores, to conduct operations due to a power failure, to
make or receive telephone calls, to deliver inventory in a timely fashion, to
receive certain products from vendors or to process electronically customer
sales at the store level. The Company does not anticipate that any such impact
would be material to its liquidity or results of operations.
The Company believes it has identified all business critical computer-based
processes through interviews with key business managers, and the Company has
worked with such managers to create contingency plans for such processes in the
event of a Y2K related systems failure. The Company believes that the
contingency plans provide a viable alternative for such processes to ensure that
the Company's core business operations are able to continue in the event of such
a failure. The Company will be continually reviewing the contingency plans with
all business units before January 1, 2000 to ensure that business is not
interrupted as a result of the Y2K issue. If the Company's business critical
systems encounter any failures, the Company believes that the contingency plans
will be implemented to allow normal business to proceed while failed systems are
repaired. If the Company encounters Y2K related failures and its contingency
plans are not sufficient to address such failures, the Company's business,
financial condition and results of operations may be materially and adversely
affected. Such adverse effects may include, but may not be limited to, the
ability to manage store operations, collect revenues from customers, supply
stores with inventory, make payments to vendors and suppliers, remit wages to
employees, and conduct other essential business-related activities.
Through December 1, 1999, the Company has expended approximately $1,791,700
to address Y2K compliance issues. Y2K costs have been funded through cash from
operations and available borrowings under the Senior Facility.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company is subject to interest rate risk associated with its debt
instruments. The market risk inherent in the Company's debt instruments
represents the increased interest costs arising from adverse changes in interest
rates (primarily LIBOR and prime bank rates). The Company is party to financial
instruments with off-balance-sheet risk which are entered into in the normal
course of business to meet its financing needs and to manage its exposure to
fluctuations in market rates. These financial instruments include swap
agreements and interest rate caps. The instruments involve, to a varying degree,
elements of credit and market risk in addition to amounts recognized in the
financial statements. The Company does not hold or issue financial instruments
for trading purposes. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-K for the year ended April 30, 1999.
The Company operates internationally in Canada, and thus is subject to
potentially adverse movements in foreign exchange currency rate changes. The
Company does not enter into foreign exchange forward contracts to reduce its
exposure to foreign currency rate changes on inter-company foreign currency
denominated balance sheet positions. Historically, the effect of movements in
the exchange rates have been immaterial to the consolidated operating results of
the Company.
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<PAGE>
PART II - OTHER INFORMATION
- ---------------------------
Item 1. Legal Proceedings
In connection with the acquisition of the assets of Videoland, Inc.
("Videoland") in November 1995, the Company issued 239,163 shares of its Class A
Common Stock (the "Videoland Shares") to the sellers of the assets of Videoland
(the "Videoland Sellers"). With respect to the Videoland Shares, the Company
agreed to make a deficiency payment in October 1996 to the Videoland Sellers if
the gross proceeds received by such sellers from the sale of the Videoland
Shares during the six months from March 1996 through September 1996 is not equal
to the number of shares of Videoland Shares sold multiplied by $12.00. The
Videoland Sellers were subject to certain "lockup" or sale restrictions as a
condition to any deficiency payment. The Company initiated an action in federal
district court in Minnesota for a declaratory judgment that the Videoland
Sellers are not entitled to any deficiency payment in light of the failure by
such sellers to comply with the lockup or sale restrictions. In January 1998,
the court entered a judgment, payable in the Company's stock or cash, against
the Company in the amount of $1,220,403 plus interest from October 1996, and
attorney's fees. The Company appealed the judgment to the Eighth Circuit. The
appeal was denied. The Company is exploring further avenues of relief, including
but not limited to the satisfaction of a portion of the judgment by a transfer
of the Company's stock, of which no assurances can be given. The foregoing
description is qualified in its entirety by reference to the full text of the
complaint and papers on file in the action (Case No. 3-96 735).
In May 1998, Rousnam Video, Inc., a Michigan corporation and Hani (Al)
Monsour (collectively "Monsour") filed a lawsuit in state court (Macomb County,
Michigan) claiming amounts due pursuant to post-closing adjustments contemplated
in connection with an Asset Purchase Agreement among Monsour and Moovies, Inc.
dated as of March 14, 1997, and the alleged default on a Promissory Note among
Monsour and Moovies, Inc. in the amount of $2,000,000 which is currently
reflected in notes payable. The trial court has ruled in favor of the plaintiffs
on a motion for summary judgment, and a judgment for $2,370,195 has been entered
against the Company. The Company believes it has meritorious grounds for its
appeal which is currently pending, although assurances cannot be given as to the
outcome of such action. The foregoing description is qualified in its entirety
by reference to the full text of the complaint and papers on file in the action
(Case No. 98-1998-CK).
In May 1998, four stockholders filed suit in the US District Court for the
Central District of California. The plaintiff stockholders allege that Mr.
Potter and the Company made false and misleading statements or omitted material
information about the Company and the video industry during the period April
1995 to September 1996, the date of its subsequent public offering. Plaintiffs
are seeking "at least the sum of $967,967," plus interest, additional damages
and attorneys' fees. The Company and Mr. Potter believe that the claims are
unsubstantiated, without merit and they intend to defend the matter vigorously.
A motion to dismiss the First Amended Complaint was granted, but the court
allowed Plaintiffs to re-file. At present, the Second Amended Complaint has been
filed. The Company is in the process of discovery, which is not scheduled to
close until December 1999. In addition, the Company and Mr. Potter have reached
a tentative settlement with the plaintiffs. Although no assurances can be given,
the Company expects that the settlement will become final in late December 1999
or early January 2000. The foregoing description is qualified in its entirety by
reference to the full text of the complaint and papers on file in the action
(Case No. SACV 98-415 GLT-ANx).
In August 1998, the Company filed suit in federal court in Oregon against
Rentrak Corporation, an Oregon Corporation. The Company alleges that Rentrak has
violated the federal antitrust law, given Rentrak's position in the market and
its exercise of monopoly power. Rentrak has counter-claimed for amounts it
alleges were owed by Moovies, Inc. prior to the acquisition of Moovies, Inc. by
the Company; the Company has denied that any sums are due. Discovery in the
matter is now scheduled to be completed in June 2000. The Company intends to
pursue its claims aggressively, although assurances cannot be given as to the
outcome of this matter. The foregoing description is qualified in its entirety
by reference to the full text of the complaint and papers on file in the action
(Case No. CV 98-1013-HA).
On June 20, 1999, Allen Industries, Inc., a North Carolina corporation,
filed a lawsuit against the Company claiming approximately $3 million in unpaid
invoices arising out of the conversion of various Moovies stores. The Company
has asserted that Allen Industries breached its contract and performed defective
work. The Company believes that the claims of Allen Industries are
unsubstantiated and without merit. The Company intends to defend
17 of 18
<PAGE>
the matter vigorously. The foregoing description is qualified in its entirety by
reference to the full text of the complaint and papers on file in the action
(Case No. 1:99CV640).
In addition to the above, the Company is involved in various legal
proceedings arising during the normal course of conducting business. Management
believes that the resolution of these proceedings will not have any material
adverse impact on the Company's financial statements.
Item 4. Submission of Matters to a Vote of Security Holders
On September 27, 1999, the Company held a Special Meeting of Stockholders
to consider and act upon the following matter:
To approve amendments to the Company's Certificate of Incorporation to
effect a reverse split of the Company's Class A Common Stock, $.01 par value per
share (the "Common Stock") pursuant to which a number of shares of Common Stock
then outstanding between 5 and 20 will be converted into one share depending
upon a final determination by the Board of Directors that such a reverse stock
split is in the best interest of the Company and its stockholders, and
authorizing the Board of Directors to file one such amendment.
Due to the absence of a quorum, the meeting was recessed to September 30,
1999 and again to October 13, 1999. In the absence of a quorum, the meeting
could not be lawfully and properly convened and was therefore adjourned.
Item 5. Other Information
On October 19, 1999, the Company was notified by the Nasdaq National Market
that the Company's Class A Common Stock, $.01 par value per share, was delisted
due to the Company's failure to meet certain maintenance criteria, including
minimum bid price requirements. The Company's Class A Common Stock is now quoted
on the Nasdaq OTC Bulletin Board.
Item 6. Exhibits and Reports on Form 8-K
A. Exhibits. The following exhibits are filed herewith:
Exhibit No. Title
----------- -----
27 Financial Data Schedule
B. Reports on Form 8-K. The Company did not file any Current Reports or
amendments on Form 8-K during the fiscal quarter covered by this
report.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
VIDEO UPDATE, INC.
Date: December 15, 1999: By: /s/ Daniel A. Potter
-----------------------------------
Daniel A. Potter,
Chief Executive Officer and
Chairman of the Board of Directors
Date: December 15, 1999: By: /s/ Michael P. Gebauer
-----------------------------------
Michael P. Gebauer,
Chief Financial Officer
18 of 18
<TABLE> <S> <C>
<PAGE>
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<PERIOD-TYPE> 3-MOS 6-MOS
<FISCAL-YEAR-END> JAN-31-2000 JAN-31-2000
<PERIOD-START> JUL-31-1999 APR-30-1999
<PERIOD-END> OCT-31-1999 OCT-31-1999
<CASH> 0 1,113
<SECURITIES> 0 0
<RECEIVABLES> 0 3,739
<ALLOWANCES> 0 0
<INVENTORY> 0 51,110
<CURRENT-ASSETS> 0 0
<PP&E> 0 81,414
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<COMMON> 0 293
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 0 194,632
<SALES> 5,587 11,487
<TOTAL-REVENUES> 54,487 114,551
<CGS> 3,929 7,141
<TOTAL-COSTS> 59,572 117,550
<OTHER-EXPENSES> 133 180
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 4,797 8,794
<INCOME-PRETAX> (9,749) (11,513)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> (9,749) (11,513)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (9,749) (11,513)
<EPS-BASIC> (0.33) (0.40)
<EPS-DILUTED> (0.33) (0.40)
</TABLE>
